The Opportunity Zone program received a considerable boost last week with several announcements during a White House convening of mayors, state policymakers, investors, and community organizations. Secretary of the Treasury Steven Mnuchin announced a second tranche of proposed regulations for the Opportunity Zone program, this time clarifying how Qualified Opportunity Funds can be used for business investment in struggling communities. He also announced a new process to explore reporting requirements. Additionally, HUD Secretary Ben Carson released the implementation plan for the White House Opportunity and Revitalization Council.
US President Donald Trump addresses the Opportunity Zone Conference with state, local, tribal, and community leaders on April 17, 2019. Tia Dufour/The White House
Overall, the new regulations and the implementation plan take a positive step by providing the clarity needed by investors, particularly those who want to support businesses in Opportunity Zones. However, reasonable reporting requirements are needed to protect communities from abuse and to collect data for future program improvement.
As a quick refresher: The Opportunity Zone program was created in the 2017 tax law to channel some of the unrealized capital gains into long-term investments in low-income neighborhoods through Qualified Opportunity Funds. The bill contained a package of tax incentives that grow over time by offering investors the chance to reduce their capital gains tax liability by 15 percent and face no tax on any appreciation of investments in the zone. To secure the maximum benefit, funds must stay invested for at least ten years, creating a new source of patient capital.
To date, most of the Qualified Opportunity Fund energy has been around real estate, in large part because the rules were clearer for investors and developers. This second tranche of regulations removes most of the uncertainty that have held back business investment. As a result, we’re likely to see the creation of new Qualified Opportunity Funds focusing on economic development, business growth, and creating jobs.
For a more complete overview, check out The Economic Innovation Group’s excellent summary of the regulations. But a few provisions are worth highlighting.
The new proposed regulations address one of the primary concerns that have held investors back from investing in operating businesses. The first tranche of regulations proposed that 50 percent of the gross income of a Qualified Opportunity Zone Business had to be derived from the active conduct of a trade or business in the qualified opportunity zone. Investors and business owners have been concerned that a business headquartered within an Opportunity Zone might not be able to satisfy this income test if the business’s sales are to customers physically located outside the Opportunity Zone. The requirement was intended to prevent abuse, but given the narrow construction, it would have limited the types of eligible business to retail stores and coffee shops instead of the next tech startup.
Treasury’s new proposed regulations keep the income test, but provide three safe harbors and a facts and circumstances test through which a business can qualify. This should help provide enough flexibility to cover service-oriented businesses and internet-based startups.
Treasury also proposes giving Qualified Opportunity Funds six months to invest capital received from investors. This additional flexibility gives fund managers a more reasonable timeframe to deploy capital in projects.
As a result, I expect we will see new venture capital oriented Qualified Opportunity Funds. As Steve Case’s Rise of the Rest tour has shown, there are businesses with incredible entrepreneurial energy around the country that have been starved of the capital needed to grow their innovations. Qualified Opportunity Funds can be a solution.
Treasury also released a new request for information seeking comments on reporting requirements, such as job creation, poverty reduction, and new business starts. The RFI is welcomed, but it’s puzzling why Treasury didn’t just start with the initial reporting requirements that were part of the original bill but later stripped out. Senators Scott and Booker are expected to introduce legislation to reinstate those reporting requirements, but Treasury can do it now through its regulatory authority. They could also use as a starting point the criteria in the OZ Framework which reflects the consensus of a broad coalition of stakeholders.
The desire to not tie up projects with too much red tape is commendable, but reporting is critical to help monitor impact, prevent abuse, and provide information for further program adjustments in the future. There are also emerging platforms, such as the Opportunity Exchange, which can reduce the data burden by capturing these metrics at the front end of project development.
Along with the new regulations, the White House released the implementation planfor the Opportunity and Revitalization Council. The plan organizes cabinet agencies around a set of five activities: Economic Development, Entrepreneurship, Safe Neighborhoods, Education & Workforce Development, and Measurement. The Council has already identified 160 programs that can be targeted to entities within Opportunity Zones through grant preference points, loan qualifications, reduced fees, and eligibility criteria. For example, the US Department of Education is giving competitive preference to CTE projects serving Opportunity Zones under the Perkins Innovation and Modernization Grant Program. These are important efforts that can complement Opportunity Fund investments or help further mitigate the investment risk with some projects.
Overall, all of these actions help to remove the uncertainty that has kept capital on the sidelines. More work remains, but momentum is growing